What Is the Network Effect?

The network effect is a phenomenon whereby increased numbers of people or participants improve the value of a good or service. The Internet is an example. Initially, there were few users of the Internet. It was of relatively little value to anyone outside of the military and some research scientists.

As more users gained access to the Internet, they produced more content, information, and services. More websites were developed, and more users connected to communicate with each other. These developments made the Internet increasingly valuable to its users.

[Important: The Internet is perhaps the most notable facilitator of the network effect; the escalation of users on Internet networking platforms has been exponential, and companies leverage these platforms to access wider target markets.]

The Network Effect Explained

The rise of social media can be directly correlated with the network effect. The more users post on Twitter adding links and media, for example, the more useful the platform becomes to the public.

Similar growth through the network effect is apparent in the cases of Facebook, YouTube, and Instagram. The escalation of users on these networking platforms is exponential. Corporations have sought to participate with these platforms to engage in expanding conversations among the many consumers who interact online.

Key Takeaways

  • The network effect is a phenomenon whereby an increasing number of people or participants who are exposed to a company, good, or service can increase the value of the company, good, or service.
  • E-commerce sites, such as Etsy and eBay, grew in popularity by accessing online networks and attracting consumers to their services and products.
  • Some companies cannot achieve critical mass—the number of users needed for the network effect to take hold—even with access to online and offline networks.
  • Congestion is a negative network effect whereby too many users can cause the network to slow down reducing its utility and frustrating network members.

What the Network Effect Means to Businesses

A variety of services-for-hire apps and websites benefit from the network effect. As more professionals list their services online, such as dog walkers, tutors, or even electricians, more customers rely on online directories. E-commerce sites, such as Etsy and eBay, grew in popularity as more sellers joined those marketplaces and sold their products to consumers who embraced online shopping.

Ridesharing services also evolved and grew through the support of participants who signed up and expanding their reach across cities and states. As more drivers became part of Uber and Lyft, the brands gained in market value.

[Fast Fact: Some of the leading, fastest-growing companies have achieved success because of the network effects. Examples are Facebook, Apple's app store, and Airbnb.]

Challenges for the Network Effect

The chief hurdle for any good or service that uses the network effect is gaining traction or attracting enough users initially so that the network effect takes hold. The amount of users required for significant network effects is called the critical mass. After critical mass is attained, the good or service attracts many new users because the network offers utility.

If too many people use a good or service, congestion can occur. Congestion is a negative network effect. For the Internet example, too many users on the same network service can slow the speed of the network decreasing the utility for users. Providers of goods and services that use a network effect must ensure that capacity can be increased sufficiently to accommodate all users.